Turn Your Home into a Powerhouse with a HELOC

If you’re a homeowner, you already know your home is one of your biggest assets—but did you know it can also work hard for you as a financial tool? A home equity line of credit (HELOC) lets you tap into the equity you’ve built to fund what you need, when you need it. Whether you’re thinking about a renovation, managing unexpected expenses or consolidating debt, a HELOC offers flexible access to funds on your terms. Here’s everything you need to know about how it works and how to make the most of it.

How does a HELOC work?

Unlike your primary mortgage, a HELOC isn’t paid out in a lump sum. Instead, you access the money when you need it, like a credit card. The period when you can access these funds usually lasts anywhere from 5–10 years and is referred to as the draw period. During this time, you’re only required to pay interest on the money you use.

When the draw period is over, the repayment period begins. This phase lasts from 10–20 years and includes payments toward principal and interest.

When shopping for a HELOC, be sure to compare rates and ask each lender how long approval takes—both can vary significantly.

Home Equity Loans & Second Mortgages Rates

How can I use a HELOC?

One of the biggest advantages of a HELOC is its flexibility—the funds don’t have to go toward your home. They are yours to spend however you choose. Common uses for a HELOC are:

• Debt consolidation

• Home renovations

• College education costs

• Landscaping

• Medical expenses

• Vehicle purchase

• Property investment

• Start-up business expenditures

HELOC requirements

To get started with a HELOC, you’ll first want to know your numbers. There are certain home equity loan requirements that your credit union or bank will want to see, like a low debt-to-income ratio (DTI), a good credit score and a certain percentage of equity in your home.

1. Low debt-to-income ratio

   Your DTI is the percentage of your monthly income (before taxes) that goes toward paying debts like mortgages, auto loans, credit cards and student loans. The acceptable percentage range varies by lender, but a good target ratio is 47% or less. Lenders want to ensure you can afford to borrow more money while keeping up with your other financial obligations, so the lower the DTI, the better.

   To calculate your DTI, add up all your monthly debt payments. This includes your mortgage principal and interest, taxes, home insurance, car loan, child support and other debts you’re legally responsible for paying. Divide this total by your monthly gross income, and multiply that number by 100 to get your percentage.

2. A good to excellent credit score

   While qualifying for a HELOC is more dependent on your home equity than your credit score, good or excellent credit makes it easier to qualify. Plus, the better your credit score, the better your interest rate. A good number to aim for is 620 or higher.
   

3. Home equity

   Your loan-to-value ratio (LTV) is your current loan balance divided by the current appraised value of your home. With a HELOC, you’ll likely need your combined loan-to-value ratio (CLTV). You get this number by adding how much you want to borrow (line of credit amount) with how much you owe on your home. Divide that total by the current appraised value of your home. Most lenders require a CLTV of 85% or less.

   Here's an example:

   $400,000 [loan balance + HELOC amount]

   ÷ $640,000 [current appraisal value]

   = 0.625

   Multiply that answer by 100:

   0.625 x 100 = 62.5%

   CLTV is 62.5%.

How to calculate a HELOC payment

Let’s say you have a HELOC balance of $75,000 at a rate of 7.25%, with a 10-year draw period. During the draw period, when you’re paying interest only, your payment would be calculated like this:

$75,000 x .0725 = $5,437.50

$5,437.50 ÷ 12 months = $453.13

Your monthly payment is $453.13 during the first 10 years.

Paying back your HELOC

Then, once you enter the repayment period, you pay the principal plus interest, so your monthly payments increase. When you enter the repayment period, your loan converts to a closed-end loan, so you no longer have that line of credit. If you want, you can negotiate with your lender to have that line extended.

As your draw period comes to a close, consider your options to either pay off or refinance your HELOC:

1. Pay the HELOC in full

   If you have the funds available, pay off the remaining balance in full to avoid additional interest.

2. Refinance into a new HELOC and new draw period

   You can keep accessing HELOC funds and postpone your initial payoff period.

3. Refinance into a home equity loan

   With this option, you get a fixed interest rate and term, but you can no longer draw funds.

How to get the most from your HELOC

To use your HELOC to your best advantage, here are tips to maximize this financial strategy:

• Don’t withdraw more than you need.

• Understand how a HELOC works and how much it will cost you.

• Read the fine print—be aware of any upfront costs, closing costs or annual fees, and note key dates like when your draw period ends and when you’ll need to pay off or refinance your balance.

• Make payments on the principal during the draw period to reduce interest charges.

• Get the best rate with a good credit score, strong LTV and adequate equity in your home.

• Determine your payback plan, set a budget and stick to it.

A HELOC can be a smart option when you need access to extra cash, and because it’s secured against your home’s equity, lenders often offer competitive rates. Before moving forward, make sure the payment fits your budget and you fully understand the loan terms. If you have questions about HELOCs or other financial strategies, reach out to an expert at Mountain America Credit Union—we’d be happy to help.